Political Calculations
Unexpectedly Intriguing!
January 24, 2018

As a general rule, we don't often comment on individual stocks, much less forecast their likely trajectory, the way we do with the S&P 500. When we do, it is often because we've picked up on something interesting or contrary about the stock in question.

That was the case just over two months ago, when we focused rather specifically on the situation of General Electric (NYSE: GE), where we indicated that the company's stock price "had further to fall", even after the company had just announced that it would slash its dividends per share in half.

At the time, GE was trading at $18 per share, where we initially anticipated that it would fall to trade within a range between $14 and $16 per share. Just a few days later, after doing a more refined analysis incorporating more historic data points defining the relationship between the company's share price and its expected forward twelve month dividends per share, we revised that target range to be slightly higher, where we projected that GE's share price would drop to be somewhere between $15 and $17 per share.

Two months later, despite having benefited from the general market exuberance associated with the passage of the Tax Cuts and Jobs Act of 2017 in the meantime, our revised projection for the future of GE's stock price has come to pass, allowing us to close the window on what we had predicted would happen in the "near future".

GE Stock Price per Share vs Expected Forward Year Dividends per Share on Dates of Dividend Change Announcements and Declarations, 
2009-2018, Snapshot on 19 January 2018

The proximate cause for GE's sudden decline in fortune into our projected target range during the last week was the revelation that the company would have to take a significant charge to its books from an old venture where the company's insurance division issued long-term care policies where the company underestimate its risk of negative exposure. Although the company stopped issuing new policies years ago, new claims against its existing portfolio will drain cash that the company doesn't have, even after the passage of permanent corporate tax rate cuts in the U.S.

GE's new CEO, John Flannery, has also raised the possibility that the industrial conglomerate will split itself into several different, independent companies as part of its overall restructuring.

There is a very high likelihood then that GE, as we have known it, has itself come to pass. Its future now very much hinges on how much traction that Flannery can get in turning around GE's fall as a whole, and whether or not he can avoid having to divvy up what remains of what once was one of the biggest of all the blue chips in the U.S. stock market, if not the world.

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January 23, 2018

When a scientist realizes that they've made a fundamental error in their research that has the potential to invalidate their findings, they are often confronted with an ethical dilemma in determining what course of action that they might take to address the situation. Richard Mann, a young researcher from Uppsala University, lived through that scenario back in 2012, when a colleague contacted him right before he presented a lecture based on the results of his research that he had a problem that called his results into question.

When he gave his seminar, Mann marked the slides displaying his questionable results with the words "caution, possibly invalid". But he was still not convinced that a full retraction of his paper, published in Plos Computational Biology, was necessary, and he spent the next few weeks debating whether he could simply correct his mistake with a new analysis rather than retract the paper.

But after about a month, he came to see that a full retraction was the better option as it was going to take him at least six months to wade through the mess that the faulty analysis had created. However, it had occurred to him that there was a third option: to keep quiet about his mistake and hope that no one noticed it.

After numerous sleepless nights grappling with the ethics of such silence, he eventually plumped for retraction. And looking back, it is easy to say that he made the right choice, he remarks. "But I would be amazed if people in that situation genuinely do not have thoughts about [keeping quiet]. I had first, second and third thoughts." It was his longing to be able to sleep properly again that convinced him to stay on the ethical path, he adds.

Mann's case represents a success story for ethics in science, where his choices to demonstrate personal integrity and to provide transparency regarding the errors he had made through the retraction of his work proved to have no impact on his professional career, though he may have feared it. Such are the rewards of integrity and transparency in science, where the honest pursuit of truth outweighs both personal reputation and professional standing.

Still, an 2017 anonymous straw poll of 220 scientists indicated that 5% would choose to do nothing if they detected an error in their own work after it had been published in a high-impact journal, where they would hope that none of their peers would ever notice, while another 9% would only retract a paper if another researcher had specifically identified their error.

According to Nature, only a tiny fraction of published papers are ever retracted, even though a considerably higher percentage of scientists have admitted to knowing of issues that would potentially invalidate their published results in confidential surveys.

The reasons behind the rise in retractions are still unclear. "I don't think that there is suddenly a boom in the production of fraudulent or erroneous work," says John Ioannidis, a professor of health policy at Stanford University School of Medicine in California, who has spent much of his career tracking how medical science produces flawed results.

In surveys, around 1–2% of scientists admit to having fabricated, falsified or modified data or results at least once (D. Fanelli PLoS ONE 4, e5738; 2009). But over the past decade, retraction notices for published papers have increased from 0.001% of the total to only about 0.02%. And, Ioannidis says, that subset of papers is "the tip of the iceberg" — too small and fragmentary for any useful conclusions to be drawn about the overall rates of sloppiness or misconduct.

There is, of course, a difference between errors resulting from what Ioannidis calles "sloppiness", which can run the gamut from data measurement errors to the use of less-than-optimal analytical methods, which can all happen to honest researchers, and those that get baked into research findings through knowing misconduct.

The good news is that for honest scientists who act to disclose errors in their work, there is no career penalty. And why should there be? They are making science work the way that it should, where they are contributing to the advancement of their field where the communication of what works and what doesn't work has value. As serial entrepreneur James Altucher has said, "honesty is the fastest way to prevent a mistake from turning into a failure."

The bigger problem is posed by those individuals who put other goals ahead of honesty. The ones who choose to remain silent when they know their findings will fail to stand up to serious scrutiny. Or worse, the ones who choose to engage in irrational, hateful attacks against the individuals who detect and report their scientific misconduct as a means to distract attention away from it, which is another form of refusing to acknowledge the errors in their work.

The latter population are known as pseudoscientists. Fortunately, they're a very small minority, but unfortunately, they create outsized problems within their fields of study, where they can continue to do damage until they're exposed and isolated.

Previously on Political Calculations


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January 22, 2018

Wall Street certainly didn't have much in the way of negative thoughts with respect to the prospects for a federal government shut down last week. Even though White House Office of Management and Budget and interim Consumer Finance Protection Bureau director Mick Mulvaney gave a "between 50 and 60 percent" chance that the U.S. Congress would fail to reach an agreement to keep the entire government open as a legislative deadline neared, which was widely known well before the market closed, U.S. stock prices went on to close on Friday, 19 January 2018 at their highest level ever.

Alternative Futures - S&P 500 - 2018Q1 - Standard Model - Snapshot on 19 January 2018

That's largely because where investors are concerned, politicians do little more than offer noisy distraction. Except for those very rare times where they might do something that actually affects the interests of investors, such as changing tax laws, it just isn't worth taking the time and energy to pay much attention to the things that grandstanding politicians say. Particularly where federal government shutdowns are concerned, seeing as there have now been no fewer than 19 since the passage of the 1974 Congressional Budget and Impoundment Control Act, which has made shutdowns like this latest one a recurring feature of how elected politicians choose to manage the U.S. government.

As for what things do attract the attention of investors, the trajectory of stock prices during Week 3 of January 2018 suggests that they are presently focusing much of their attention on 2018-Q4 and the expectations associated with that distant future quarter. Previously, we had thought investors might be splitting their focus between 2018-Q1 and 2018-Q3, but with the probability of a Fed rate hike occurring in 2018-Q3 now seemingly a low probability event, a shift in investor focus to 2018-Q4 appears to be a better explanation for what we're observing.

We should also note that the accuracy of our dividend futures-based model's projections are currently being affected by the echo effect from the past volatility of stock prices, which arises as a result of our model's use of historic stock prices as the base reference points for making its projections of the future. Here, since the magnitude of the current echo is relatively low, our model's projections for all alternative futures for the period from 11 January through 24 January 2018 are slightly understated from what they would be if no echo effect were present in the projections.

Taking that small understatement into account along with what we know about how far forward in time investors are looking, we find that the S&P 500 is tracking along the lower end of the range that we would expect they would if investors were closely focused on 2018-Q4 in setting today's stock prices, which frankly is not much different from what the unadjusted chart above indicates. To the extent that investors solidify their attention on 2018-Q4, we may have come to the end of the Lévy flight event that characterized the movement of U.S. stock prices during the first two weeks of 2018.

Regardless, outside of the better-than-even odds that the U.S. government would need to shut down a portion of its operations after Friday, 19 January 2018, there wasn't much notable in the news headlines of the third week of January 2018.

Tuesday, 16 January 2018
Wednesday, 17 January 2018
Thursday, 18 January 2018
Friday, 19 January 2018

The Big Picture's weekly listing of all the positives and negatives that Barry Ritholtz saw for the U.S. economy and markets in the holiday-shortened third week of January 2018 is up!

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January 19, 2018

One week ago, the Wall Street Journal broke the news that the World Bank had a serious problem with one of its most popular and useful products, its annual Doing Business index.

The World Bank repeatedly changed the methodology of one of its flagship economic reports over several years in ways it now says were unfair and misleading.

The World Bank’s chief economist, Paul Romer, told The Wall Street Journal on Friday he would correct and recalculate national rankings of business competitiveness in the report called “Doing Business” going back at least four years.

The revisions could be particularly relevant to Chile, whose standings have been volatile in recent years—and potentially tainted by political motivations of World Bank staff, Mr. Romer said.

The report is one of the most visible World Bank initiatives, ranking countries around the world by the competitiveness of their business environment. Countries compete against each other to improve their standings, and the report draws extensive international media coverage.

In the days since, Romer has clarified that he doesn't believe that the World Bank staff engaged in a politically-motivated strategy aimed at disadvantaging Chile's position within its annual rankings, but instead failed to adequately explain how changes that the World Bank's staff made in updating their methodology of its Doing Business index affected Chile's position within the rankings from year to year.

Looking at the controversy from the outside, we can see why a political bias on the part of the World Bank's staff might be suspected, where positive and negative changes in Chile's position within the annual rankings coincided with changes in the occupancy of Chile's presidential palace.

That's why we appreciate Romer's willingness to openly discuss the methods and issues with communication, including his own, that have contributed to the situation. In time, thanks to the demonstrations of integrity and transparency that Romer is providing today as the staff of the World Bank works to resolve the issues that have been raised, the people who look to the Doing Business product will be able to have confidence in its quality. That will be the reward of demonstrating integrity and providing full transparency during a pretty mild version of an international public relations crisis.

Not every matter involving correcting the record has the worldwide visibility of what is happening at the World Bank. We can find similar demonstrations of the benefits of integrity and transparency at a much smaller scale, where we only have to go back a couple of weeks to find an example. Economist John Cochrane made a logical mistake in arguing that property taxes are progressive, which is to say that people who earn higher annual incomes pay higher property taxes than people who earn lower annual incomes.

In search of support for his argument, he requested pointers to data indicating property taxes paid by income level from his readers, who responded with results that directly contradicted his argument. How he handled the contradiction demonstrates considerable integrity.

Every now again in writing a blog one puts down an idea that is not only wrong, but pretty obviously wrong if one had stopped to think about 10 minutes about it. So it is with the idea I floated on my last post that property taxes are progressive.

Morris Davis sends along the following data from the current population survey.

No, Martha (John) property taxes are not progressive, and they're not even flat, and not even in California where there is such a thing as a $10 million dollar house. (In other states you might be pressed to spend that much money even if you could.) People with lower incomes spend a larger fraction of income on housing, and so pay more property taxes as a function of income. Mo says this fact is not commonly recognized when assessing the progressivity of taxes.

Not only is Cochrane providing insight into the error in his thinking, his transparency in addressing why it was incorrect is helping to advance the general knowledge of his readers.

In both these cases, we have examples of problems that could have been simply swept under a rug and virtually ignored with nobody being the wiser, but where the ethical standards of the people involved wouldn't let them do that. Even in making mistakes while addressing the mistakes they made or discovered, they made the problems known as they worked to resolve them, and because they did so, we can have greater confidence in trusting the overall quality of their work.

In the real world where people value honesty, admitting or acknowledging errors is no penalty. In fact, there are solid examples where scientists have retracted papers because of errors they made that, ultimately, had zero impact on their careers. Which in some cases, involved going on to be awarded Nobel prizes in their fields.

Retracting a paper is supposed to be a kiss of death to a career in science, right? Not if you think that winning a Nobel Prize is a mark of achievement, which pretty much everyone does.

Just ask Michael Rosbash, who shared the 2017 Nobel Prize in physiology or medicine for his work on circadian rhythms, aka the body's internal clock. Rosbash, of Brandeis University and the Howard Hughes Medical Institute, retracted a paper in 2016 because the results couldn't be replicated. The researcher who couldn't replicate them? Michael Young, who shared the 2017 Nobel with Rosbash.

This wasn't a first. Harvard's Jack Szostak retracted a paper in 2009. Months later, he got that early morning call from the Nobel committee for his work. And he hasn't been afraid to correct the record since, either. In 2016, Szostak and his colleagues published a paper in Nature Chemistry that offered potentially breakthrough clues for how RNA might have preceded DNA as the key chemical of life on Earth - a possibility that has captivated and frustrated biologists for half a century. But when Tivoli Olsen, a researcher in Szostak's lab, repeated the experiments last year, she couldn't get the same results. The scientists had made a mistake interpreting their initial data. Once that realization settled in, they retracted the paper - a turn of events Szostak described as "definitely embarrassing."

What isn’t absurd is the idea that admitting mistakes shouldn’t be an indelible mark of Cain that kills your career.

Indeed it shouldn't. And for honest people with high standards of ethical integrity and a willingness to be transparent about the mistakes that they have made or that have occurred on their watch, it isn't.

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January 18, 2018

The relative period of order for the S&P 500 that began back on 31 March 2016 has come to an end.

The breakdown of order in the S&P 500 became clearly evident on 11 January 2018, when the level of the S&P 500 surged to be more than three standard deviations above the mean trend curve that has described the relationship between stock prices and their trailing year dividends per share since the end of the first quarter of 2016. Tracing this break in trend backwards to when it first took hold, we find that the last day that the previous period of relative order could be reasonably be said to have held is 29 December 2017, the last day of trading at the end of the fourth quarter of 2017, which is when stock prices were last within one standard deviation of the established mean trend curve.

S&P 500 Index Value vs Trailing Year Dividends per Share, 30 September 2015 Through 17 January 2018, with Period of Order Between 31 March 2016 and 29 December 2017

That makes the explanation for what caused the break in order relatively easy to determine. We believe that it may be fully attributed to the passage of the Tax Cuts and Jobs Act of 2017 on 22 December 2017, the provisions of which would take effect in 1 January 2018, to which investors would respond vigorously to their new incentives from the law beginning with the first day of trading in 2018 on 2 January 2018. It then took just eight trading days for the break in the previous period of relative order in the U.S. stock market to become definitive.

The new incentives for investors arise from the large and permanent reduction in corporate income tax rates, where investors may benefit by realizing larger dividend payments, by companies using their newly-freed funds to increase their productive investments, to lower their prices to consumers to gain market share, to better insulate themselves against having arbitrarily higher costs from government-mandated expenses imposed upon them (firms boosting the wages of their lowest paid employees can be said to be taking this action), or to simply use the opportunity of the newly-freed funds to improve their balance sheets. Or some combination of any or all of the above.

In a number of ways, the initial response of the stock market to the passage of the Tax Cuts and Jobs Act of 2017 is similar to what happened to stock prices following the passage of the Tax Relief Act of 1997, which caused the Dot Com stock market bubble to inflate. Unlike that event, where the differences in tax rates between dividends and capital gains changed the rate of return math for investors with dramatic and unstable effects upon stock prices, the changes that U.S. firms make in response to the Tax Cuts and Jobs Act of 2017 are much more likely to affect the fundamental expectations that investors have for their future business prospects, making a similar bubble unlikely.

No matter what, the U.S. stock market has entered into a very different period than it was before. How will that affect your investment decisions?

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